(FORTUNE Magazine) – A GENERATION AGO during brief warm moments in the big chill between the U.S. and the Soviet Union, the stock market would sometimes drop, led by a retreat from defense issues. When that happened, some Wall Streeters wryly called it ''a peace scare.'' But the market did not so much as blink at the astounding arms-limitation offers that President Reagan and General Secretary Gorbachev exchanged at Reykjavik in October. To be sure, the meetings broke up without an agreement, but the proposals the two men explored were breathtaking: Reagan suggested that over ten years both sides dispose of ballistic missiles, while Gorbachev offered a still more sweeping plan to junk nuclear weapons altogether. The economic reality of nuclear arms control is that no matter what form it takes, defense spending is not going to drop -- although with a Democratic Congress pledged to protect domestic programs it isn't likely to go up much either. The U.S. spends about $40 billion, close to 15% of the defense budget, on a nuclear arsenal that includes 11,000 warheads. Under any of four possible scenarios -- no nuclear weapons, no ballistic missiles, a limit of 6,000 or so warheads on each side, or no arms control at all -- the money will almost surely be shifted from one nuclear program to another or to conventional weapons to make up for the loss of nuclear arms. Major defense companies by and large are so diversified that even if all nuclear weapons were eliminated -- an unlikely prospect -- they would not suffer much (see table). But any changes in the arsenal would shuttle enormous sums of money around the country, impoverishing some communities and enriching others. A limit of 6,000 warheads, for example, might severely curtail plutonium production at Du Pont's Savannah River plant, one of the largest employers in South Carolina. A ban on ballistic missiles might send Groton, Connecticut, where Trident submarines are made, into a decline. In that case towns in southern California, home of the B-1B bomber, would thrive. Gorbachev's proposal that both the U.S. and the Soviet Union eliminate nuclear weapons altogether rather than just do away with ballistic missiles may not have been wholly serious. Neither superpower wants to trash its nuclear force completely, not in a world in which China, France, and Great Britain pack nuclear weapons and India, Israel, Pakistan, and South Africa are thought to have them as well. And far from freeing money for useful civilian purposes, getting rid of nuclear weapons -- assuming that the U.S. still wants to stand up to the Soviets in Europe -- would be the most expensive alternative. Kim Holmes, the defense analyst for the Heritage Foundation, guesses that the U.S. might have to increase its defense budget by at least 20% a year until the end of the century if it were to try to make up for a lost nuclear force by matching the Soviets in troops and conventional weapons. The U.S. has 2.2 million men and women under arms, vs. 5.3 million for the Soviets; American troops earn more than 100 times the pay of their Russian counterparts. NATO, which has about 18,000 tanks, probably would not try to go tread to tread with the Warsaw Pact's 46,000, but it would most likely buy a lot more tank killers, such as Bell and McDonnell Douglas attack helicopters. To speed equipment to Europe in a crisis, the U.S. would have to amass transport planes, many made by Lockheed, and have National Steel & Shipbuilding, among others, reconstruct a lot of old cargo vessels. And the Pentagon would accelerate the development of high-tech devices like a robot tank that FMC Corp. is working on. Ballistic missiles, launched from silos or submarines and so called because they follow a ballistic trajectory to targets thousands of miles away, are the only weapon fast enough for a disabling surprise strike. Any country that has them will be tempted to consider that with the right timing -- and an accurate count of the other side's weapons -- it might be able to vaporize the enemy before it had time to retaliate. Since Reykjavik, President Reagan's arms negotiators have given up on outlawing ballistic missiles right away but still consider it the long-term goal. If ballistic missiles were banned, the U.S. would not only have to give up the Trident sub, which the Navy buys for $l.5 billion apiece from General Dynamics at the rate of about one a year, but also get rid of 24 Trident II missiles in each sub. Losing that $1-billion-a-year business could be a serious blow to Lockheed and many of the 6,500 workers at its Sunnyvale, California, plant. But General Dynamics would be in a strong position to pick up more business elsewhere, such as fighter interceptors. And the Navy could go on buying additional nuclear-powered attack submarines, which would help keep GD's Electric Boat Division afloat. Other ballistic weapons banned would be the Minuteman intercontinental missiles stuffed in silos in the north central U.S. and the new Peacekeeper (MX) ICBMs that carry up to ten warheads and are more accurate than Minutemen. Assembly lines at Boeing, GTE, and Rockwell International stopped making Minutemen some time ago, so corporate contracts and jobs are in no jeopardy. The government has already appropriated $16 billion to pay contractors such as Martin Marietta, Rockwell, and Aerojet General for the total production run of 50 Peacekeepers, ten of which are already on duty. But the U.S. would have to abandon plans for a mobile Midgetman missile; six major contractors are competing to make parts of it. IN A WORLD without ballistic missiles the U.S. would have a military edge, because it is less dependent on ICBMs than the Soviet Union. The U.S. has an impressive collection of what are known in military-industrial jargon as air breathers: jet-propelled cruise missiles and bombers. In the absence of ballistic missiles, air breathers would play the key retaliatory role. The U.S. cruise missiles can be launched from air, sea, or land and are probably more accurate and tougher to detect than the Soviet versions. The U.S. is paying Rockwell $2.8 billion for a fleet of 100 Rockwell International B-1B bombers that will eventually replace its ancient B-52s, some of which have already been sent to the boneyard (see Managing). The B-1Bs will be able to launch cruise missiles from afar or penetrate Soviet air space to fire short- range air-to-ground missiles made by Boeing. Then in the early 1990s Northrop will start delivering the first of 132 Stealth bombers designed to foil radar with smooth contours and materials such as carbon fiber and graphite that absorb rather than reflect radar waves. A strategic air force of 232 planes is not enough, especially if the U.S. had no ballistic missiles to rely on, says Jeffrey Record, a senior fellow at the Institute for Foreign Policy Analysis, a private research group. Record points out that the strategic fleet is by far the smallest it has been since before World War II; he thinks it should be two to three times as large. In May Rockwell offered to sell additional B-1Bs for $195 million a copy. The Stealth bomber is so secret that the Pentagon will not disclose either its specifications or its cost. Outsiders guess that the Stealth bombers will cost $60 billion to $80 billion in all. That includes a lot of research and development, so the unit price of additional planes would drop sharply. What the U.S. and the Soviets may well be able to agree on is a ceiling of something like 6,000 warheads for each side, about half the number each will have in a year or so at the normal rate of increase. That is the current formal U.S. proposal on the table at Geneva. But even though the U.S. stock of warheads would decline by almost 50%, maintaining the strategic force would not get any cheaper. The U.S. would probably discard old warheads and replace them with new ones. ''The history of arms control is that countries go on doing what they want to do and stop doing what they no longer want to do,'' says Gordon Adams, defense scholar at the Center on Budget and Policy Priorities, an independent Washington research group. Most likely, the U.S. would fill its 6,000-warhead allotment with the weapons least vulnerable to a surprise strike. For now that means weapons that are kept in motion on expensive machines operated by well-paid specialists. The U.S. could go ahead with its plan to expand the Trident fleet from eight subs to 18, carrying up to 4,320 warheads in all. Another 1,200 warheads would most likely be on cruise missiles and on short-range attack missiles launched from Stealth bombers. The remaining 480 might go in Peacekeeper missiles that would ultimately be replaced by smaller, mobile Midgetmen. That would let the U.S. retire old Minuteman missiles and the more than 200 remaining B-52 bombers. ABOUT THE ONLY savings in this realignment would come from mining the discarded weapons for their uranium and plutonium. The fissionable material can be reshaped and fitted into new warheads. Plutonium production at the Savannah River plant in Aiken, South Carolina, might slow dramatically. That would not erode Du Pont's earnings, because the chemical company operates the government-owned plant for cost plus $1. But a slowdown could have a serious effect on the local economy; the plant employs 13,000 people. Similarly, the limitation on nuclear testing that would almost certainly accompany such an arms control agreement would eliminate some jobs in Nevada. EG&G, a high-tech company with headquarters on Route 128 outside Boston, employs 7,500 people at the U.S. underground nuclear testing site at Yucca Flat. They drill mile-long shafts into which the weapons are set for detonation, and make and monitor the instruments that measure the blasts. The government pays EG&G about $650 million a year for these services. If testing were curtailed, EG&G's profits -- $56 million in 1985 -- would fall a bit, although with fewer tests the government would want to have more instruments crammed into each hole. A final possible scenario is no arms control at all. For now, informal arms control is in effect, because both the U.S. and the Soviets are more or less observing the limits on ballistic missile launchers and air breathers imposed by the second Strategic Arms Limitation Treaty. President Reagan declines to ask Congress to ratify the 1979 agreement, however, and has just exceeded its limits by having the Air Force put one more B-52 with cruise missiles on duty. The Russians have been cheating, the President points out. True, but if the Soviets really wanted to kick the lid off the limits, the CIA estimates that they have the capability to swell their store of nuclear warheads from about 10,000 to 21,000 by the mid-1990s. While they are unlikely to do that, analysts at the Congressional Budget Office have pounded their calculators to figure out how much it would cost the U.S. to match them if they did. The cheapest way, costing $27 billion, would be for the U.S. to buy an additional 867 MX Peacekeepers. That would be a windfall for 15 major contractors, including Rockwell, which makes rocket motors at Canoga Park, California, and Boeing, which will test and assemble the missiles at F.E. Warren Air Force Base in Wyoming. The next most expensive response would be for the U.S. to buy an additional 270 B-1B bombers, for at least $54 billion at Rockwell's price last spring. That would keep 25,000 Rockwell workers in Columbus, Tulsa, and El Segundo and Palmdale, California, riveting and painting for years. Without any further orders, Rockwell expects to close down its B-1B line in April 1988. The high-priced alternative would be to build an extra 36 Trident subs and their missiles for around $90 billion. That's expensive, but the Trident is perhaps the most fearsome weapon the U.S. has; the Russians can't find the subs underwater. A fourth possibility would be a mixed platter of all three systems, Peacekeepers, B-1Bs, and Tridents -- a likely compromise after a period of pushing and pulling by Congressmen to secure jobs for their districts. NO MATTER WHAT happens to arms control, the U.S. still has one embarrassing gap in its defenses to fill. What has been largely ignored in the debate over the Strategic Defense Initiative, Reagan's ambitious plan for protection against ballistic missiles, is that the U.S. has almost no defense against air-breathing bombers and cruise missiles that could slip under an anti-ICBM screen. In 1960 the DEW Line of radar stations across Canada, radar ships, Nike-Hercules and Hawk antiaircraft missiles, and 2,700 interceptor planes provided the U.S. with the world's best air defense. Since the mid-1960s the DEW Line has been somewhat improved, but the antiaircraft missile installations and 90% of the interceptors have been removed on the theory that fighters and missiles are useless against Soviet ICBMs. They probably would have been effective against the slow and clumsy Bear and Bison bombers of the 1960s and 1970s, however. Now the Russians are building a scarier bomber, nicknamed the Blackjack, which is similar to the B-1B and may be even faster. The first of the Blackjacks is expected to arrive in Soviet hangars in 1988. By the end of the decade Soviet cruise missile technology may equal that of the U.S. In defense against air breathers the Soviets are far superior, at least on paper: They have 10,000 radar stations, 14,000 surface-to-air missile launchers, and 1,200 interceptors to protect the homeland. Just how competent those guardians are was called into question three years ago when a Soviet interceptor pilot apparently mistook Korean Air Lines flight 007, a big, slow-moving 747, for a spy plane and shot it down. But Soviet air defenses have no doubt been tightened as a result. If the U.S. can make its air breathers ''stealthy'' -- that is, nearly undetectable by radar -- in time the Soviets will undoubtedly be able to do so as well. So while it perfects its own stealth know-how, the U.S. will also have to find antidotes -- radar and other sensors that can detect all-but- invisible intruders. Boeing, General Electric, General Dynamics, Grumman, Hughes, Lockheed, and Rockwell have won small contracts from the Pentagon to think about the gadgets a modern air surveillance system should have. Shooting down a bomber or a cruise missile traveling at 700 mph or so is easier than felling a 10,000-mph ballistic missile, but expensive nonetheless. Raytheon makes the successor to the Nike-Hercules and Hawk -- the Patriot surface-to-air missile now used to defend NATO bases in Europe. With no rivals in its field, the Patriot would be the prime candidate to protect the U.S. as well. It might take 26 Patriot batteries around the U.S. to do the job, at $116 million a battery, plus $9 million a year to operate each one. On top of that, the U.S. will probably have to buy l,000 or more interceptors, possibly a mixture of all-weather $27-million McDonnell Douglas F-15s and less versatile $17-million General Dynamics F-16s.

So the market was right not to panic over the Reykjavik proposals. All things considered, neither defense contractors nor Wall Street should fear peace scares.